Caution from Buyers and Sellers as Mid-Market Slowdown Continues

In the midst of headlines about large-cap M&A transactions, mid-market deals often get lost in the shuffle. Transactions on the lower transaction end have seen a decrease recently despite the many mega deals that have been executed.

According to FactSet, the number of M&A deals worth less than $100 million decreased by 12.6% to 2184 from 2500 at year ending 12/29/16 compared to the same period a year ago.

“The size of the big M&A deals that have been announced skew the numbers for M&A, in general,” says Dennis McCarthy, a managing director in Monarch Bay Securities LLC.

On a macro-level, there are many factors impacting activity. “There are several factors that could be causing the M&A slowdown. There’s the economy and the potential for another recession, there’s what’s happening in China, as well as the election year,” says Kurt Estes, a director at Sikich Investment Banking.

Political and economic uncertainty affects general investing and M&A activity as buyers become more cautious. “At some point, interest rates will be rising and that will affect what buyers will be willing to pay. As a result, asset prices might go down,” Estes says.

Caution from Buyers and Sellers

These economic problems are making buyers hold back, which plays into the slower pace of deal activity.

“The buyers of these businesses, especially private equity firms, are ready, wiling, and able to invest,” says Michael Fanelli, a partner in the New York office of RSM US LLP. “However, buyers are also very much in tune with U.S. and global events and what all the pundits are saying. Investors are constantly looking at energy prices and how fast or slow interest rates are going to rise in 2016 and 2017. There has been conflicting macro data. Jobs and manufacturing are doing better, but stock markets have been down.”

There is also restraint emanating from lessons learned from past experience. “Generally, the big corporates that I deal with have learned to be cautious after going through a period before the downturn when they were more aggressive,” Monarch Bay’s McCarthy says. “There’s also a greater level of caution for buyers that need financing from the financial markets.”

He adds that many buyers coming out of the last surge of M&A found that many of the deals did not fare well. “They are now looking for a better fit and deals that ‘move the needle.’ So if you’re a business development guy at a large-sized company, you’re selective to find the good options that justify the time, attention, and risk,” McCarthy says.

Like buyers, some sellers in certain industries are also mindful of previous negative events, which are informing their decisions on how to go forward with their respective businesses. “From my lens as an M&A adviser in a specific market segment — business services — standpoint, we are seeing a slowdown. Looking back at this industry particularly, the 2008 recession had a very significant impact on the space,” says Mike Ginsberg, president & CEO of Kaulkin Ginsberg Company.

Ginsberg explains that companies had to deal with the economic and regulatory changes brought about by the recession while many of them had to manage regulatory compliance costs, which have resulted in slower M&A activity. “The services industry also had to go through the consolidation of their clients such as banks and healthcare companies,” he says. “It took time for them to cope with and adjust to these changes and that has been negatively impacting the number of deals in the mid-market.”

Optimism for the Future

Despite these setbacks, there is still some optimism as well as market activity to look forward to.

“We saw a little bit of a slowdown in January so the market did not see many deals closing in February and March. But, it’s going to turn around, based on what I’m hearing from bankers and private equity firms I have spoken with,” says RSM’s Fanelli.

Sikich’s Estes agrees with this assessment based on the transactions they have in the works. “The first quarter is typically slow across the board for M&A. But here at Sikich, we are seeing a lot of deal activity. While I understand that on a macro level there is a slowdown, we are not seeing it,” Estes says.

Bright Spots

Though the mid-market has seen a drop in deal activity, there are certain parts of the space that are alive and well and that are churning out transactions.

Healthcare is one area where market participants expect growth even with several unknowns. “Although people are getting a better handle on the Affordable Care Act, there’s still a lot of regulatory uncertainty. In the presidential election, one side is promising to expand the law while the other side wants to end it,” says Sikich’s Estes. “But there’s another factor involved, which is the certainty of an aging population.”

Despite the uncertainty of regulation, Estes explains that there is a macro factor of population, which has to be paid for. However, not everything in healthcare will be active in terms of M&A, especially the segments dependent on government reimbursement, Medicare, and Medicaid.

There are sub-segments of healthcare that are expected experience some deal action as well. Monarch Bay’s McCarthy points to healthcare IT (HIT). “Given the increasing number of hack attacks on hospitals, these firms will need to spend more money on cyber security despite the historical focus on making information more available throughout the medical community,” he says. “But as these attacks happen more often, HIT companies are likely to become more acquisitive and buy cyber security firms so they can offer this expertise to hospital groups.”

Another subsector of healthcare that has seen a high level of activity is the good-for-you healthy living space, both for consumer goods and food & beverage. “This segment has seen higher-than-historical activity as companies tap into the interest from millennials and the younger generation,” RSM’s Fanelli says. “That’s where some private equity clients are looking for opportunities.”

Other segments that are showing a lot of deal promise include student loans, energy, and natural resources.

Kaulkin’s Ginsberg says that in the student loan world, there has been more borrowing and there is a portion of the borrower base that will experience delinquency. “These loans and delinquencies need to be managed and this function is usually outsourced to third-party specialists by the Department of Education and colleges,” he says. “These third-party service companies often need to acquire platforms, infrastructure, and staff that have the expertise and there will likely be a lot of activity from them going forward.”

Energy-related deals have also seen some traction. “The market is actively trying to figure out when the bottom for oil prices is going to happen,” Fanelli says. “There is value based on currently distressed assets that can turn a profit in the future when oil and gas prices turn up.”

Indeed, distressed investing is a key theme in the energy and other related sectors. “Natural resources and energy are going to be active areas since there are many companies that are in distress,” says Monarch Bay’s McCarthy. “This can be a major area of consolidation as these firms have to combine to survive, which is good news for M&A, but not for the industry.”